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Personal Finance Blog By MoneyRates - November 2010

Starting in July 2011, state-chartered banks will have to take an extra step to ensure their automated overdraft protection programs don't take advantage of customers who can least afford to pay the fees.

Under final new guidelines issued Nov. 24 by the Federal Insurance Deposit Corp., banks will have to contact customers enrolled in the programs who overdraw their checking accounts more than six times a year. The banks must inform them about cheaper alternatives, such as linking a checking account to savings accounts or inexpensive lines of credit. Banks also must limit how much customers can pay in overdraft fees a day -- either by limiting the number of transactions subject to a fee or limiting the total amount of fees that can be imposed in one day.

The new guidelines discourage unfair transaction posting -- the practice of reordering checks and debit card transactions to deduct the largest amounts first, thereby increasing the number of overdraft fees customers are charged. The Center for Responsible Lending urged other regulators to follow the FDIC's lead. The FDIC supervises only state-chartered banks and does not have authority over the nation's largest banks.

Checking account overdraft protection: Frequent users pay big bucks

The FDIC guidelines come on the heels of Federal Reserve regulations requiring banks to get customers' permission to enroll them in debit card overdraft protection programs, which charge customers a fee each time they overdraw their checking accounts. Before, banks covered the overdrafts automatically and some customers, not realizing their balances had reached zero, racked up hundreds of dollars in overdraft fee, with each fee typically averaging $35.

These fees are often spread disproportionately among bank customers, with about 90 percent of overdraft fee revenue coming from a small number of customers who frequently overdraw their checking account, according to Moebs Services a financial research firm in Lake Bluff, Ill.

Overdraft input from all sides

The FDIC received more than 900 written comments about the proposed guidelines. Most banks expressed concern about a growing regulatory burden, while many consumers gave examples of being subject to "repeated and often disproportionate" automated overdraft program fees.

"Consumers raised concerns about bank practices to maximize overdraft fees, confusion over disclosures of account balances, and transaction processing order," an FDIC report about the new guidelines stated. "After reviewing public comments, the FDIC continues to believe that there are significant reputational and safety and soundness risks associated with many overdraft payment programs."

The FDIC's Quarterly Banking Profile announced some good news for the banking industry. The good news for banks might also translate into good news for savings accounts, money market accounts, and other deposits.

The Quarterly Banking Profile is a comprehensive report on the aggregate financial health of FDIC-insured institutions. According to the most recent report, that health is getting decidedly better.

Bank profits up

Overall, bank profits have soared over the past year, from $2 billion in the third quarter of 2009 to $14.5 billion in the third quarter of 2010. 63.3 percent of the FDIC's 7,760 insured institutions reported higher net income in the third quarter than they'd had a year earlier.

With this profitability, banks are shaking off some of the ill effects of the financial crisis. Non-current loans -- those on which payments have fallen seriously behind -- declined for the second consecutive quarter. Prior to the last two quarters, non-current loan balances had risen for 16 consecutive quarters.

Tellingly, only 18.9 percent of FDIC-insured institutions reported being unprofitable. This is down from 27 percent a year earlier, and represents the smallest percentage of banks with negative net income since the second quarter of 2008.

While bank profits were soaring, amounts on deposit experienced only 1.5 percent growth, and time deposits (money in accounts like CDs which are committed for a set period of time) declined for the seventh consecutive quarter.

These trends will come as no surprise to anyone who is familiar with the low levels of bank rates these days. Savings and money market rates give customers scant reason to deposit money, and in particular people are reluctant to lock money into a CD at the current low rates.

Improved profitability might help change this. Deposits help fund bank loans and investment activity. When those areas became unprofitable, banks had little incentive to attract deposits. Now that lending is recovering and investments are doing well, attracting more deposits can help banks grow profits.

This could be the first step towards banks offering higher CD, savings, and money market rates.

Q: I am concerned that inflation is going to come back in a big way. What would be the safest thing to be in if that happens: stocks, bonds, or money market accounts?

A: Inflation is a destructive force which fortunately has been fairly benign for nearly thirty years now. However, if you are curious about what might happen if inflation flares up, there is a period of high inflation from the past you can look at as an example.

From the beginning of 1968 through the end of 1981, U.S. inflation averaged 7.6 percent a year, reaching a high of 13.31 percent in 1979. Over the course of these fourteen years of high inflation, large-cap stocks averaged just 6.0 percent a year, and long-term Treasuries averaged just 3.3 percent a year. In other words, both lost ground to inflation over this period.

It was short-term T-bills that came closest to hanging in there against inflation during this period, averaged 7.2 percent a year while inflation averaged 7.6 percent. You could expect savings accounts or money market accounts to behave most similarly to T-bills, since both represent short-term interest rates.

Some takeaways from this are as follows:

'Safe' is a relative term when high inflation strikes. It's more a matter of limiting damage than coming out ahead.

Staying short-term is the best immediate defense. Short-term vehicles like T-bills and money market accounts are at least able to adjust rapidly to changing conditions.

Long bonds have the toughest time when inflation rises. This would be especially true now, because bond yields are so low.

Stocks and bonds have other strengths. Stocks have had the highest returns when a full range of conditions is considered, and bonds should do very well when inflation is declining.

In short, if you think inflation is going to be rising, you could do much worse than T-bills or money market accounts.

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Between fiscal troubles in Ireland and conflict in Korea, there's been no shortage of bad news to disrupt the financial markets lately. There has been one piece of good news over the past couple weeks, though -- oil prices have taken a significant step back.

This is good news for anyone with money in savings accounts, CDs, or money market accounts. These deposit rates are sensitive to inflation under any circumstances, but at today's ultra-low levels, it wouldn't take much in the way of a rise in prices to put the squeeze on those rates.

The recent rise and fall of oil prices

Oil prices began this month about where they are now -- in the neighborhood of $82 a barrel. In the first two weeks of November, however, oil surged and closed as high as $87.77. It gained nearly 8 percent in less than two weeks, and all of a sudden the talk of $100-a-barrel oil was back.

Oil is not the only component of inflation, of course. However, over the past couple years it has tended to lead the inflationary trend -- both on the way up and on the way down. Oil is also a good measure of the strength of the dollar, and when the dollar is losing ground to oil, it may well be making other goods more expensive too.

This kind of commodity inflation would be the worst possible medicine for the economy now. It would represent rising prices in some areas, while the one type of inflation that could help spur economic growth -- wage inflation -- would remain absent because of a weak job market.

Fortunately, oil prices have taken a step back this week and last, and if you have money in CDs, savings accounts, or money market accounts, you can add that to your list of things to be thankful for tomorrow. As it is, you have to shop actively for the best CD rates, savings rates, and money market rates to stay ahead of inflation. You don't need rising oil prices making the job any tougher.

Until the economic meltdown, the last time most Americans thought much about the workings of the Federal Reserve system was back in college when they took Macroeconomics 101.

Fed policy, after all, isn't sexy, not even to lawmakers.

"Monetary policy has always been considered boring on Capitol Hill, something left to remote policy wonks far away from the din of presidential or congressional politics," U.S. Rep. Ron Paul of Texas writes on his website's "Texas Straight Talk" blog.

Not anymore, though, unless you consider the likes of Sarah Palin a policy wonk. Palin is among a growing list of high-profile critics, which include Paul and U.S. Rep. Mike Pence of Indiana. With the Republican victories Nov. 2, and the Fed's announcement Nov. 3 that it would purchase $600 billion in U.S. Treasury securities to spur the economy, the Fed is under an intensifying spotlight.

Attack on the Fed

Paul, who wants to do away with the Fed, is set to be the chairman of the House Subcommittee on Domestic Monetary Policy.

"While it is gratifying to see so many formerly uninterested politicians, economists, talk show hosts, and pundits suddenly rally to attack the Fed, one can only wonder whether they truly understand that central banking is inherently incompatible with our Constitution and a free market economy," he writes.

Pence, meanwhile, chairman of the House Republican Conference, introduced legislation to limit the Fed's power to price stability and protecting the dollar and end its mandate to promote employment.

Thomas Hoenig, the Fed's lone dissenter on recent monetary policy, recently accepted an invitation to speak to House Republicans in December. In the last seven meetings of the Federal Open Market Committee, Hoenig, president of the Federal Reserve Bank of Kansas City, has voted against the committee's majority opinion to keep the federal funds rate near zero.

What does the political fallout mean for mortgage rates and the interest rates you earn on certificates of deposit, money market accounts and savings accounts? Whether fiery debate will bring about changes that affect your wallet remains to be seen. One thing is sure, though, the Fed will continue to be center stage in coming months.

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Advertiser Disclosure: Many of the savings offers appearing on this site are from advertisers from which this website receives compensation for being listed here. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). These offers do not represent all deposit accounts available.